Can you get deductions for payments in lieu of penalties? The Court of Appeal says yes!
UK regulators had investigated failings by several energy providers. The investigations were settled with the imposition of nominal £1 penalties and redress payments totalling around £28m. The nominal penalties were non-deductible for corporation tax purposes. But what about the much more substantial redress payments? That was the question before the Court of Appeal in ScottishPower (SPCL) Ltd and others v HMRC [2025] EWCA Civ 3 (reported in Tax Journal, 24 January 2025).
Without the agreement on the redress payments, more substantial penalties would have been imposed by the regulator on the energy providers. In this sense, the redress payments were in lieu of penalties. HMRC argued that they should, therefore, be non-deductible for corporation tax purposes on public policy grounds.
At first and second instance, the case was decided (mostly) in favour of HMRC. The First-tier Tribunal allowed deductions only for a small amount of redress payments that it considered genuinely compensatory because the payments were made directly to affected customers. The Upper Tribunal considered the redress payments entirely non-deductible.
The Court of Appeal has now decided the case in favour of the taxpayers, holding that there is no general rule prohibiting tax deductions for redress payments in the circumstances of the case. So, the whole £28m was deductible, given the FTT’s earlier, unchallenged finding that all other requirements for deductibility had been meet (i.e. that the payments are of an income, rather than a capital, nature and are wholly and exclusively for the purposes of the taxpayers’ trades).
Is there a general rule against giving tax deductions for penalties?
Yes. Penalties are non-deductible on public policy grounds because their economic impact would otherwise be reduced, and their purpose undermined.
Does it apply to all penalties? The rule certainly applies to penalties imposed under a statutory penalty regime. Whether it also applies to penalties under a non-statutory regime (including contractual regimes such as the Formula One regulatory regime) is less clear, and the Court of Appeal leaves this point undecided.
Where does this general rule come from? The Court of Appeal preferred the analysis that this is a judge-made rule which is given effect through CTA 2009 s 46(1) which requires that a company’s taxable trading profits are ‘calculated in accordance with generally accepted accounting practice, subject to any adjustment required ... by law’. Leaving penalties out of account would be an ‘adjustment required ... by law’, namely, by case law pre-dating the relevant legislation.
Does it apply to payments in lieu of penalties?
No. The rule applies only to fines or penalties; it does not extend to amounts which are not, in fact, fines or penalties – even if they can be seen as replacing a fine or penalty. Whether a payment can be regarded as compensating the recipient for loss suffered is not crucial (although the ‘fact that a payment is compensatory may indicate that it does not have the character of a penalty’).
No authority was cited to the Court of Appeal to ‘support any general proposition that the deductibility of a payment should be determined by reference to the nature of a payment which it replaces’, and the Court of Appeal did not consider that there were any public policy reasons for extending the non-deductibility rule beyond fines and penalties. In fact, such an extension would make the scope of the rule uncertain, and there is nothing to prevent regulators from taking into account the fact that payments in lieu of penalties would be tax deductible when considering the terms of any settlement agreement.
Is the Court of Appeal’s decision the last word on the matter?
Probably not, but it is too early to say this with any certainty. Given the amounts at stake and the important policy point involved, it seems likely that HMRC will apply for permission to appeal the Court of Appeal’s decision to the Supreme Court.
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ScottishPower: payments under settlement agreements
Can you get deductions for payments in lieu of penalties? The Court of Appeal says yes!
UK regulators had investigated failings by several energy providers. The investigations were settled with the imposition of nominal £1 penalties and redress payments totalling around £28m. The nominal penalties were non-deductible for corporation tax purposes. But what about the much more substantial redress payments? That was the question before the Court of Appeal in ScottishPower (SPCL) Ltd and others v HMRC [2025] EWCA Civ 3 (reported in Tax Journal, 24 January 2025).
Without the agreement on the redress payments, more substantial penalties would have been imposed by the regulator on the energy providers. In this sense, the redress payments were in lieu of penalties. HMRC argued that they should, therefore, be non-deductible for corporation tax purposes on public policy grounds.
At first and second instance, the case was decided (mostly) in favour of HMRC. The First-tier Tribunal allowed deductions only for a small amount of redress payments that it considered genuinely compensatory because the payments were made directly to affected customers. The Upper Tribunal considered the redress payments entirely non-deductible.
The Court of Appeal has now decided the case in favour of the taxpayers, holding that there is no general rule prohibiting tax deductions for redress payments in the circumstances of the case. So, the whole £28m was deductible, given the FTT’s earlier, unchallenged finding that all other requirements for deductibility had been meet (i.e. that the payments are of an income, rather than a capital, nature and are wholly and exclusively for the purposes of the taxpayers’ trades).
Is there a general rule against giving tax deductions for penalties?
Yes. Penalties are non-deductible on public policy grounds because their economic impact would otherwise be reduced, and their purpose undermined.
Does it apply to all penalties? The rule certainly applies to penalties imposed under a statutory penalty regime. Whether it also applies to penalties under a non-statutory regime (including contractual regimes such as the Formula One regulatory regime) is less clear, and the Court of Appeal leaves this point undecided.
Where does this general rule come from? The Court of Appeal preferred the analysis that this is a judge-made rule which is given effect through CTA 2009 s 46(1) which requires that a company’s taxable trading profits are ‘calculated in accordance with generally accepted accounting practice, subject to any adjustment required ... by law’. Leaving penalties out of account would be an ‘adjustment required ... by law’, namely, by case law pre-dating the relevant legislation.
Does it apply to payments in lieu of penalties?
No. The rule applies only to fines or penalties; it does not extend to amounts which are not, in fact, fines or penalties – even if they can be seen as replacing a fine or penalty. Whether a payment can be regarded as compensating the recipient for loss suffered is not crucial (although the ‘fact that a payment is compensatory may indicate that it does not have the character of a penalty’).
No authority was cited to the Court of Appeal to ‘support any general proposition that the deductibility of a payment should be determined by reference to the nature of a payment which it replaces’, and the Court of Appeal did not consider that there were any public policy reasons for extending the non-deductibility rule beyond fines and penalties. In fact, such an extension would make the scope of the rule uncertain, and there is nothing to prevent regulators from taking into account the fact that payments in lieu of penalties would be tax deductible when considering the terms of any settlement agreement.
Is the Court of Appeal’s decision the last word on the matter?
Probably not, but it is too early to say this with any certainty. Given the amounts at stake and the important policy point involved, it seems likely that HMRC will apply for permission to appeal the Court of Appeal’s decision to the Supreme Court.
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